Best & Worst ETFs and Mutual Funds: Large-cap Value Style

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David Trainer

Mon, 2013-02-25 12:22

The large-cap value style ranks second out of the twelve fund styles as detailed in my Style Rankings for ETFs and Mutual Funds report. It gets my Neutral rating, which is based on aggregation of ratings of 39 ETFs and 728 mutual funds in the large-cap value style as of February 5th, 2013.

The large-cap value style ranks second out of the twelve fund styles as detailed in myStyle Rankings for ETFs and Mutual Fundsreport. It gets my Neutral rating, which is based on aggregation of ratings of 39 ETFs and 728 mutual funds in the large-cap value style as of February 5th, 2013. Prior reports on the best & worst ETFs and mutual funds in every sector and style arehere.

Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all large-cap value style ETFs and mutual funds are created the same. The number of holdings varies widely (from 22 to 1426), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.

Figure 3 shows that 417 out of the 1723 stocks (over 44% of the assets) in the style get an Attractive-or-better rating. However, only six out of 39 large-cap value ETFs (less than 29% of total net assets) and 15 out of 728 large-cap value mutual funds (less than 2% of total net assets) get an Attractive-or-better rating. It almost seems as if mutual fund managers are trying to avoid the good stocks.

Investors need to tread carefully when considering large-cap value ETFs and mutual funds, as 84% of ETFs and 98% of mutual funds in the large-cap value style are rated Neutral or worse.. Only six ETFs and 15 mutual funds in the large-cap value style allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating.

McDonald’s Corporation (MCD) is one of my favorite stocks held by large-cap value ETFs and mutual funds and earns my Very Attractive rating. MCD has grown its after-tax cash flow (NOPAT) by 9% compounded annually since 1998. Its return on invested capital (ROIC) has increased every year since 2002. McDonald’s current share price of ~$94.60 gives it aprice to economic book value ratioof 0.9, which means the market is currently predicting a permanent 10% decline inNOPATfor MCD. Such a large decline seems unlikely for a company that has not experienced even a minor decline inNOPATfor a decade.

American International Group, Inc. (AIG) is one of my least favorite stocks held by large-cap value ETFs and mutual funds and earns my Very Dangerous rating. AIG has anROICof only 1%, while its weighted average cost of capital (WACC) is 10%, meaning it would need to growROICby over ten times its current level to earn positiveeconomic earnings. InsteadROICis declining, driven by a 75% decrease inNOPATlast year. In fact, AIG has not earned positiveeconomic earningssince before 1998. AIG’s current share price of ~$38.20 means the market is expecting 20% growth inNOPATcompounded annually over the next 10 years. This expectation seems overly optimistic for a company with a decliningNOPATand no track record ofeconomic profitability.

Figures 4 and 5 show the rating landscape of all large-cap value ETFs and mutual funds.